Question

You are the audit supervisor of Azuma Audit firm and currently planning the audit of an existing client, SWOW Ltd. whose year-end was 30 April 2019. SWOW is a pharmaceutical company, which manufactures and supplies a wide range of medical supplies. The draft financial statements show revenue of $35·6 million and profit before tax of $5·9 million.

SWOW’s previous finance director left the company in December 2018 after it was discovered that he had been claiming fraudulent expenses from the company for a significant period of time. A new finance director was appointed in January 2019 who was previously a financial controller of a bank, and he has expressed surprise that Azuma audit firm had not uncovered the fraud during last year’s audit.

During the year SWOW has spent $1·8 million on developing several new products. These projects are at different stages of development and the draft financial statements show the full amount of $1·8 million within intangible assets. In order to fund this development, $2·0 million was borrowed from the bank and is due for repayment over a ten-year period. The bank has attached minimum profit targets as part of the loan covenants.

The new finance director has informed the audit partner that since the year end there has been an increased number of sales returns and that in the month of May over $0·5 million of goods sold in April were returned.

Azuma Audit firm attended the year-end inventory count at Sycamore’s warehouse. The auditor present raised concerns that during the count there were movements of goods in and out the warehouse and this process did not seem well controlled.

During the year, a review of plant and equipment in the factory was undertaken and surplus plant was sold, resulting in a profit on disposal of $210,000.

Required:

a) State Azuma Audit Firm’s responsibilities in relation to the prevention and detection of fraud and error.

b) Describe SIX audit risks in planning the audit of SWOW.

c) Identify and briefly explain FOUR financial statement assertions relevant to classes of transactions and events for the year under audit.

d) Prepare an outline of audit procedures that will be relevant in the audit of SWOW financial statement

Answer 1

a)

ISA 240 the Auditor's Responsibilities Relating to Fraud in an Audit of Financial Statements recognizes that misstatement in the financial statements can arise from either fraud or error. The distinguishing factor is whether the underlying action that resulted in the misstatement was intentional or unintentional.

Fraud can be further split into two types:

• fraudulent financial reporting - deliberately misstating the accounts to make the company look better/worse than it actually is
• misappropriation of assets - the theft of the company's assets such as cash or inventory.

The external auditor's responsibilities:

The external auditor is responsible for obtaining reasonable assurance that the financial statements, taken as a whole, are free from material misstatement, whether caused by fraud or error. Therefore, the external auditor has some responsibility for considering the risk of material misstatement due to fraud.

In order to achieve these auditors must maintain an attitude of professional skepticism. This means that the auditor must recognize the possibility that a material misstatement due to fraud could occur, regardless of the auditor's prior experience of the client's integrity and honesty.

ISA 315 Identifying and Assessing the Risks of Material Misstatement Through Understanding the Entity and Its Environment goes further than this general concept and requires that engagement teams discuss the susceptibility of their clients to fraud. The engagement team should also obtain information for use in identifying the risk of fraud when performing risk assessment procedures

b)

“Audit risk” is the risk that an auditor may give an inappropriate audit opinion on financial statements that are materially misstated. To reduce the audit risk to an acceptably low level means the auditor needs to be more than certain that the financial statements are not materially misstated. This is reiterated by ISA 200, which states, “The auditor should plan and perform the audit to reduce audit risk to an acceptably low level that is consistent with the objective of an audit.”

“Inherent Risk” as per ISA 400 is “the susceptibility of an account balance or class of transactions to misstatements that could be material, individually or when aggregated with misstatements in other balances or classes, assuming that there are no related internal controls”.

Assessing audit risk and inherent risk is an essential part of audit planning because it staff that need to be assigned to the particular audit. If for example there were valuation issues with property inherent risk would then be assessed as high, therefore meaning more evidence would have to be gathered and staff that are more experienced assigned to perform testing on this account.